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Going Concern Standard Approved for June Publication

May 8, 2014

The FASB said it will add a requirement to U.S. GAAP that a company’s management will have to evaluate a business’s financial health every quarter and alert investors if there’s “substantial doubt” about the company’s survival. The decision shifts the responsibility for the going concern assessment to management and away from the external auditor.

The FASB voted 5-2 on May 7, 2014, to approve publication of an accounting standard that it hopes will give a better view of a struggling company’s odds of survival.

The board expects to publish the standard in June.

The decision caps off more than five years of debate on the best way for U.S. GAAP to capture uncertainties about a company’s ability to survive. In current practice, the call to cast doubts about a business’s ability to continue as a going concern—the underlying assumption of financial reporting—belongs to the external auditor. Critics say this call often comes too late, when a business is well on its way to collapse.

Under the FASB’s plan, a business would have to disclose new information in its financial statement footnotes when there is “substantial doubt” about its survival.

The FASB’s decision is a significant shift from the plan the board floated in June 2013 with Proposed Accounting Standards Update (ASU) No. 2013-300,Presentation of Financial Statements (Topic 205)—Disclosure of Uncertainties about an Entity’s Going Concern Presumption, which would have required earlier warnings.

The proposal said managers would have to evaluate every reporting period whether the company had an uncertain future. When it became “more likely than not” that the company wouldn’t be able to meet its obligations within a year without engaging in a fire sale of assets or restructuring, the company would have to provide details about the cause of the financial problems in the financial statement footnotes, management’s evaluation of the situation, mitigating conditions, and the plans to address the problems. The information also would have been required if it became “known or probable” that the business would fall short of its financial commitments within two years.

The proposal also required public companies registered with the SEC to evaluate every fiscal quarter whether there was “substantial doubt” about their ability to remain solvent and then disclose the doubts in the footnotes. Substantial doubt would exist if the business concludes that it wouldn’t be able to meet its obligations within 24 months after the financial statement date.

In March, responding to concerns that some disclosures would turn into self-fulfilling prophesies, the FASB relaxed the original requirements. It kept the disclosure requirements in place, but said a company only would have to draw them up when there was “substantial doubt” about its future. Such doubt would exist when it was “probable” that there would be a “severe impact” on the business’s ability to realize its assets in the near term, which the board agreed was in the next 12 months, not 24.

The revisions prompted FASB member Lawrence Smith, a strong supporter of keeping the going concern project alive when it looked like it might die, to say he would dissent from the final standard.

“Academic studies have shown, in fact, on the whole, the general threshold for substantial doubt is actually below the threshold that we’ve established, and therefore I expect implementing this standard will result in a reduction of going concern opinions and disclosures,” Smith said. “I truly believe our exposure draft was far superior to what we’re putting out.”

FASB member Thomas Linsmeier also said he would dissent, but for different reasons. He said the forthcoming disclosures were inconsistent with how the FASB normally approaches financial statement disclosures. The information belongs in the management’s discussion and analysis section of a regulatory filing, which isn’t audited and covered by SEC rules, Linsemeier said.

“Management’s assessment about whether the entity will be around is not part of the basic financial statement,” he said.

In addition to approving the amendments for publication, the FASB wrapped up some late-stage decisions on the project.

The board decided that companies would be required to look forward 12 months from the date of financial statement issuance as opposed to the date of the balance sheet to determine whether there were doubts about their future.

The board also settled on the date by which companies must comply with the forthcoming rules.

Public and private companies will have to follow the standard for annual reporting periods beginning after December 15, 2015, and quarterly periods thereafter. Most calendar-year companies will make their first disclosures in 2017, FASB member Marc Siegel said.

“It took us five years to get to this in place; I’m OK with two-and-a-half years for others to get their act in place,” Siegel said.

Early adoption of the standard also will be allowed, the FASB voted.

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